The Asia Thread

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HONG KONG (MarketWatch) -- One of China's two key manufacturing surveys fell in June, coming in below economists' forecasts, according to data released Thursday. The China Federation of Logistics & Purchasing said its purchasing managers' index fell to 52.1, compared to 53.9 in May. The result missed a 53.1 consensus forecast in a Reuters poll of economists, but managed to stay above the 50 mark separating expansion from contraction. A competing PMI survey conducted by lender HSBC PLC was due out later in the day.

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Tang Yayun, a Shanghai-based analyst at Northeast Securities Co., said before the announcement. “This is a surprise given that they just completed a bond sale.” The bolded sentence is critical as it merely implies that the rot from the trillions in bad loans made to assorted house flippers, tulip sniffers, and opium den casino dwellers are finally coming home to roost. Indeed, Bank of China's capital adequacy ratio fell to 11.09 percent as of March 31, below the minimum 11.5 percent required according to the China Banking Regulatory Commission. The next wave of the solvency crisis tsunami has now officially made landfall in China.

July 11, 2010 - 10:14PM The centre-left government of Japan's new Prime Minister Naoto Kan lost its majority in parliament's upper house in elections Sunday, media exit polls showed, spelling the threat of legislative paralysis.

The government was not immediately threatened, because it holds a majority in the more powerful lower chamber, but the result makes it more difficult to pass laws and will force it to seek new coalition partners.

The election result -- the first ballot box test since Kan's party swept to power under a previous leader in a landslide poll last summer -- complicates his ambitious reform plans for the world's number two economy.

When Kan took office a month ago as Japan's fifth prime minister in four years, he pledged to restore the nation's vigour after two decades of economic malaise and to whittle down a huge public debt mountain.

The one-time leftist activist also promised to strengthen the social safety net for the rapidly ageing society and raised the prospect of tax hikes to pay for it all -- a gamble that backfired badly on election day.

If Kan, the 63-year-old former finance minister and self-declared "son of a salaryman", or man of the people, was looking for a strong mandate from Japan's more than 100 million eligible voters, he was left disappointed.

His Democratic Party of Japan (DPJ) will hold no more than 113 out of the 242 seats in the House of Councillors -- far short of the 122 seats needed for a majority -- according to an exit poll by public broadcaster NHK.

Other television stations forecast even worse results for the coalition government, which now includes one other small party, meaning it will have trouble pushing laws through the bicameral parliament.

Instead, Kan's government will have to engage in coalition talks to seek the support of smaller parties, with pundits pointing at the Buddhist-backed New Komeito Party and the year-old Your Party as the most likely contenders.

It's a disappointing state of affairs for the party that less than a year ago took power in what was widely hailed as an electoral earthquake that ended more than half a century of almost unbroken conservative rule.

When the DPJ took power last September under former premier Yukio Hatoyama, it promised to end the murky backroom politics of the business-friendly Liberal Democratic Party (LDP) and the powerful state bureaucracy.

Hatoyama pledged to return power to the people, make the capitalist powerhouse a kinder, gentler society, and forge less subservient ties with the United States, Japan's main security ally since the end of World War II.

Instead, he resigned after less than nine months in office -- brought down by his indecisive leadership, a dispute over an unpopular US airbase, and funding scandals that reminded voters of Japan's political business as usual.

When Kan, the former deputy premier, took over in early June, he was initially greeted by approval ratings above 60 percent -- but the honeymoon period ended within weeks after Kan brought up the subject of raising taxes.

Newspaper editorials praised Kan for having the courage to speak of the option of doubling the five-percent sales tax to bring down the huge public deficit, which is nearing 200 percent of gross domestic product.

But when Kan's poll rating immediately dived, he quickly softened his proposal, stressing that any possible tax hike was years away -- a move that in turn left him open to charges of backtracking.

Goshi Hosono, deputy secretary general at the DPJ, said shortly after polls closed that "very tough predictions are being released".

"Prime Minister Kan has issued bold messages regarding fiscal conditions. Perhaps, unfortunately, it was difficult for his message to reach the people."

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I'm reading on FX blogs financial indecision and stalemate in Tokyo from this. It appears the global perfect storm is forming.

if indecision and stalemate= perfect financial storm then you are right. this is soooooooo typical of japan. to do anything one needs not a simple majority but a crushing majority. the kan gov't, if they have truly lost the upper house, is going to be a lame duck gov't. unless they can get a strong coalition together. they had their chance with hatoyama (son or grandson (cant remember which off the top of my head) of a war criminal who was pardoned as soon as the US realised the extend of the 'red threat' in the late 40s early 50s) but he blew it.

even with a strong majority in both houses, innovative/paradigm shifting reform would be very hard to push through in japan. without both houses its impossible.

so if you have any money making scenarios for a stagnant japan, now would probably be a good time to implement 'em.

(note: this is not financial advice, nor is it sober advice. but if you profit from it i wouldn't complain if i got a case of 16 yr old lagavulin or 15 yr old laphroig. or a single bottle of 30 yo laphroig (simply because i had the chance to get it on my 30th birthday and, stupidly, passed it up. if you don't profit from it i will simply say 1. i was drunk & 2. you get what you pay for.)

in short, i guess what i'm trying to say is that japan is and will continue to be a basket case and i really want to drink good scotch

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Most likely, this slowdown reflects government administrative measures to curb lending to property and infrastructure investment. Iron-ore and copper imports, for instance, just fell for the third straight month.

There is a view that for balanced trade China must boost domestic demand rather than re-peg its currency higher. Still, this will take time and need major structural reforms to lessen the dominance of the state in the economy and boost consumption. Recent increases in the minimum wage of factory workers are a start perhaps.

To continue covering the country in concrete buildings and new highways does not seem to be the answer. The mainland Chinese habit of holding multiple properties empty as investment looks a particularly inefficient way to run an economy.

In general, little attention was given to the efficiency of the banks' stimulus lending, which was after all, state-decreed. Add in that it was majority state-owned but publicly listed banks that were doing the lending to municipal government investment vehicles, and everything gets a little bit incestuous. Another complicating factor is the stimulus spending took place in a growing property bubble.

Now, analysts have begun drilling down on these loans and, perhaps unsurprisingly, some of the predictions are quite alarming.

Capital Economics, a London-based consultancy, predicts that the mainland's local government investment vehicles -- which borrowed the majority of the banks 9.6 trillion yuan ($1.4 trillion) stimulus last year -- face bankruptcy. These "window companies" amassed 7.34 trillion yuan of loans by the end of 2009, according to government data.

A recent move by the banking regulator to ordered lenders to refuse further credit to the 8,000-plus window companies set up by municipal governments to fund infrastructure projects means many will face bankruptcy, says Capital Economics. In June, the China Banking Regulatory Commission called for credit to be withdrawn because of heightened risks in the property sector.

If the order is carried out, they predict the investment vehicles will either go bust saddling the banks with bad debt, or they will need to be bailed out by the central government. Either way, the mess will end up on Beijing's lap.

All said, Beijing has potentially enough problems of its own just now to be cut a bit of slack on its trade surplus.

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LOS ANGELES (MarketWatch) -- Japan's benchmark wholesale-price index fell 0.4% in June compared with May, the Bank of Japan said Monday. Compared to the same month a year earlier, the corporate goods price index was 0.5% higher. The negative month-on-month reading was the first such decline since October 2009, the BOJ said, and it compared to a revised gain of 0.2% in May. Both the central bank and the government have said pulling Japan out of deflation ranks among their top goals.

Given that China bought 70 per cent of the world's iron ore exports last year, and Australia's iron ore exports this year will be worth about $US50 billion, it is not hard to see that the huge Chinese tail wind for Australia's national income is no longer blowing like it was.

The underlying reason for Australia's once-in-a century resources boom was that China's heavy industry sector has been growing much faster than its overall economy. The boom was inflated by distortions in the economy linked to China's hybrid market-authoritarian form of government.

Now a series of command-economy edicts has flipped this pattern around. Steel production has been falling in absolute terms for two months and the rate of decline accelerated through June. That was despite a surge in exports as mills pocketed export rebates before they are scrapped today.

Over the coming decade the trend in Chinese resource consumption - and therefore Australian national income - will be determined partly by consumer and investor preferences. But the aggregate of those private choices will be trammelled by policy and political choices that the Chinese leadership will either face or evade.

Many of those challenges will be outlined tomorrow at the Australian National University's China Update conference. Zhongxiang Zhang will look at China's efforts to reduce fossil fuel consumption, and its equally serious challenges. Last year China installed more wind power turbines than any other nation. And yet, in the first quarter of this year, 60 per cent of wind power generation capacity was wasted because it was not hooked up to the grid.

Huw McKay and Ligang Song will calculate how China's per capita steel consumption could peak earlier and at a higher rate than previously assumed - at double the present rate of consumption in little over a decade.

However, for my money these policy debates will be swamped in coming years by the core question of whether and how a one-party state can make itself accountable.

Over-construction will continue so long as officials receive great financial incentives and few political and legal disincentives against bribery and stealing land. State-dominated heavy industry

will continue to over-produce so long as the services sector is stunted by politically powerful state monopolies.

That is why Yongsheng Zhang, at the State Council's Development Research Centre, will tomorrow tackle the question of whether local officials can ever be held accountable to their people when they are appointed from above.

And Yang Yao, the director of Peking University's China Centre for Economic Research, goes even more directly to the heart of things. He writes that the key to China's reform-era success is that the party did not allow policy to be hijacked by special interest groups at the expense of other sectors of the population. But that is now changing, as cadres meld seamlessly into the world of crony capitalism.

''While the private business community is realising the importance of cultivating the government for larger profits, it is the government itself, its cronies and government controlled [state owned enterprises] that are quickly forming strong and exclusive interest groups,'' he writes.

''All this suggests that some form of explicit political transition will be necessary to counterbalance the formation of strong and exclusive interest groups. The Chinese Communist Party must soon realise that there is no alternative to fuller democratisation if it wishes to maintain both high economic growth and enhance social stability.''

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Great credit expansions prompt investment decisions that only make sense within the fantasy-world created by a relentless deluge of new money. When the flow of new money slows or when the true nature of the inflation-fueled boom becomes apparent to a critical mass of people, many of the investments prompted by the easy money fail and the economy enters a recession. If the government then 'fights' the adjustment process by propping-up prices and dramatically increasing its own indebtedness, the recession will potentially transform into a depression. For example, it was most likely the government's response to the post-1929 and post-1990 economic downturns in the US and Japan, respectively, that converted recessions into depressions (where a depression is defined as more than a decade of slow, or no, real economic progress).

Being rife with mal-investments encouraged by a seemingly endless flow of new money and credit, China's economy has been acutely vulnerable for some time. It could have remained superficially strong as long as the government was willing to promote further credit expansion or until inflation risk became a widespread concern, but it was just a matter of time before the gross misdirection of resources started to take a visible toll. As it turned out, the combination of a steeper upward trend in the prices of food and other essentials, obvious bubbles in the residential real estate markets of several major Chinese cities and blatant over-building in the commercial property sector pushed China's policy-makers into crimping the flow of new credit during the first half of this year. The result is a growing pile of evidence that China's economy is now in a slump. For example, the following information was included in Joan McCullough's morning comment to the clients of East Shore Partners on 30th June:

"...if you look at one month interbank rates in Shanghai, you will see that they have climbed steadily up to 4%. While the one-year interest rate is only 1%. Uh-oh. Houston, we have a problem.

And evidently, talk is that domestic liquidity is very tight as foreign capital inflows have stopped. And as a stillpegged currency, M1 expansion (Renminbi) has also stopped. Meanwhile, they are experiencing inflation which has the US dollar trading at a premium in the black market as compared to where it is trading officially. This is not good. None of it. Money quietly flowing out. As a matter of fact, some even suggest that the $2.4 tril in dollar reserves which the world is always trying to pinpoint and which we all automatically, unquestioningly attribute to trade surplus are not what they appear. Rather, some cognoscenti suggest that perhaps less than half that number is attributable to trade. The balance? How about "borrowed" from global speculators?

Anecdotally local iron ore traders kid that the present is a good time for them to take vacation as things are so slow. Steel prices, as a matter of fact, have fallen for 7 weeks. And the car inventory distribution channels are said to be 6-months stuffed but this has been camouflaged. Because "reported car sales" are being counted exfactory, not as final sales."

We knew of the downward trend in steel prices and the proclivity of China's official bean-counters to count a consumer good as "sold" as soon it leaves the factory. We also knew that China's vaunted currency reserve stems from speculative capital flows in addition to trade flows. We didn't know about the elevated level of one-month SHIBOR (Shanghai Inter-Bank Offered Rate) relative to one-year SHIBOR, although we note -- by referring to http://www.shibor.or...ml/index_e.html -- that the gap between these rates has since contracted to around 0.2%. And we didn't know -- and haven't been able to verify -- that the US$ has recently traded in the black market at a premium to its official exchange rate against the Yuan.

Interestingly, a lot of people are still citing the "China story" as a reason to be bullish on industrial commodities. The completely bogus GDP numbers spewed out by China's 'ministry of information' help foster such beliefs, but you don't have to dig far beneath the surface to find evidence of an economy in trouble.

That being said, the unusually high level of control that China's government exerts over the rate of credit expansion in both the private and public sectors means that it will be important to stay alert for signs of a policy shift from 'tightening' to 'easing'. To put it another way, we shouldn't under-estimate the Chinese government's ability to re-ignite the inflation-fueled boom. When the next policy-shift occurs in China it will probably be time to turn intermediate-term bullish on industrial commodities, but right now the outlook remains bearish because China is still headed down the 'tightening' path and the rate of global economic growth is slowing.

Here are a few ideas on how to hedge against or speculate on additional weakness in China's economy, especially if equity markets rebound over the coming days (a rebound would create a better opportunity to enter bearish positions):

1. Buy put options on the stocks of major industrial-metal producers such as FCX and VALE (as one of the world's largest iron-ore and nickel producers, VALE would be hurt by further weakening in the demand for steel).

Swan will be creaming his pants. Budget surplus will be restored next Tuesday. We'll see what the BDI says in a few days

Swan on lateline last night explaining why they are now taking 10.5Bn from the new mining tax said their forward projections show prices tapering off. Of course the moment capacity exceeds demand prices do not taper off they fall quite dramatically.

Who knows when this will occur and whether it will be capacity building (which is happening) or demand falling (which could happen) but you would be a fool to rely on this income I think even beyond 12 months! The miners have sold him the forward projections of volume which are massive due to the upgrades occurring now but what they fail to take into account is with that high volume exported this is the very same capacity which will decimate the price. We might look at our volume and say it is a drop in the worldwide ocean but Brazil is doing the same capacity building as we are! This is how things with long capacity building lead times go. Minerals always have moved in a cycle and it is not necessary for demand to fall for prices to come crashing down. This actually goes for minerals and houses!

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LOS ANGELES (MarketWatch) -- Chinese steel producers have a demand problem, and some analysts say they see little relief in sight, even if prices for iron ore ease.

Falling demand, particularly in China, has cast a shadow over the sector, and Goldman Sachs has a tipped the problems to continue at least until the fourth quarter. See Asia Markets column on overall steel outlook.

China economic data released Thursday added to the poor outlook, as second-quarter gross domestic product growth cooled and price inflation continued to slow in June. See full report on Chinese economic data.

HONG KONG (MarketWatch) -- China reported a slowdown in second-quarter gross domestic product growth, as well as in a number of other economic indicators for June on Thursday, indicating the nation's rapid expansion was beginning to cool as Beijing withdrew some expansionary policies.

The annualized first-half GDP growth came in at 11.1% higher than in the same period a year ago, but slower than the 11.9% annual growth recorded in the first quarter. The size of the nation's economy grew to 17.284 trillion yuan ($2.553 trillion) as a result, according to the National Bureau of Statistics of China.

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65 million empty houses is what? You don't think building empty shopping malls, suburbs, high rises etc is bizarre?

The population of Beijing is 22 million.

The crux of the bubble is the real estate is overvalued to incomes. Bit like the empty apartments, condos in the North Shore, Gold Coast etc are overvalued.

Pretty pointless the Chinese building all this sh*t and no one can use it at current prices.

I am just saying that probably because of its size 65 mil homes empty in China is not as bad as it looks like, don't forget they are 1 bil people in china, an occupancy rate like australia of 2.4 would imply 400 mil homes over there, 65 mil less homes is an occupancy of 3, so when you get a gdp growth of 10% like in China a 0.6 movement in occupancy rate is possible. Still they probably have a housing bubble probably not because of too many empty houses but because too much of gdp is related to construction. But I might be wrong as I haven't studied too much about china

In the first half 2010, according to trust company reports, the value of wealth management products cooperatively offered by banks and trusts rose to 2.6 trillion yuan ($380 billion), topping the previous year's 1.77 trillion yuan.

This amount -- combined with the 4.58 trillion yuan in on-the-books, new credit issued by banks in the first half -- brought total lending in China through June 30 to near the 7.5 trillion yuan limit set by the government for all 2010.

"Banks have been fervent (lenders) during the past two months," explained one official at the China Banking Regulatory Commission (CBRC).

By Bloomberg News - Jul 20, 2010Three dozen cranes tower over the Tianjin West Railway Station, part of a 501-billion yuan ($74- billion) government-funded building boom in this city of 9.8 million southeast of Beijing.

Like hundreds of other local Chinese projects, Tianjin’s construction is financed in part by land sales that are dropping as China’s real-estate slump takes hold. Property sales slid at an annual 8 percent rate in June. Selling land produced 41 percent of Tianjin’s income last year, according to China Index Academy, a Beijing real-estate research firm.

A cascading collapse in local finances could force the central government to shore up banks that lent to local government entities, said Jim Walker, chief economist at Hong Kong-based Asianomics Ltd., in a June 7 interview. Banks could “easily” be saddled with bad loans of more than $400 billion over the next two years, he said.

“These local-government vehicles probably hope their projects will be able to service their debts,” Walker said. “If they don’t I doubt they’ll worry about repaying the loans; they will just assume that somewhere else in government will have to take on the bad debt.”

After their success in propelling growth, local authorities are now faced with the consequences of Premier Wen Jiabao’s crackdown on the real-estate bubble. Falling property sales risk an erosion of revenue accounting for as much as 30 percent of local budgets, according to Standard Chartered Bank. [sounds a lot like Canberra!]

“Local governments were encouraged to invest in these projects and now they’re feeling like, ‘Hey, wait a minute!’” said Barry Naughton, author of the 2007 book “The Chinese Economy: Transitions and Growth” and a China specialist at the University of California San Diego. “They will be taking their funding platforms to Beijing and saying: ‘We’re going to go bankrupt. You have to do something about it.’”

China has more than 1,000 county-level governments and hundreds of city and municipal councils that get revenue from local taxes, land sales and central-government transfers. Authorities sold or allocated 319,000 hectares (788,266 acres) of property last year, up 44 percent from 2008, netting a record 1.6 trillion yuan, Ministry of Land and Resources data show.

Economic Engine

Wen’s government aims to make Tianjin’s Binhai New Area an economic engine akin to Hong Kong neighbor Shenzhen and Shanghai’s Pudong. Tianjin reported 180.5 billion yuan in revenue last year. While the data don’t detail land sales, China Index Academy estimates the receipts at 73.2 billion yuan, a 67 percent surge over 2008.

Duan’s assessment contrasts with National Bureau of Statistics figures last week that showed real-estate sales across the country fell for a second straight month in June compared with a year earlier.

The reversal comes amid a slowdown across the world’s third-largest economy. China’s expansion cooled to an annual pace of 10.3 percent in the second quarter, according to data released last week, from 11.9 percent in January to March.

More Slowing?

The growth rate for industrial production in June dropped the most since 2008, excluding distortions from the Lunar New Year holiday, signaling a further deceleration in the economy in the second half of the year.

Policy makers are seeking to cushion the decline in property by promoting low-cost housing, a strategy that itself is complicated by newly falling prices.

“What we’re likely to see is that local governments will hold onto the land and wait until prices are reasonable before supplying it,” said Ren Zhiqiang, chairman of Beijing-based developer Huayuan Property Co. Ltd., at a forum in Beijing on July 12.

Sales of land for residential use in 103 cities in China dropped 28 percent in June from May, China Index Academy said in a statement on July 13. Shenzhen-based developer Gemdale Corp. saw first-half contracted sales fall 37 percent to 5.4 billion yuan and 43 percent by area to 482,900 square meters, according to a July 10 statement.

JPMorgan Chase & Co. cut its profit estimates for China’s property developers by an average 9 percent in 2010 and 11 percent in 2011 due to a “substantial slowdown” in transactions, analysts led by Raymond Ngai wrote last month.

Lending by China Merchants to local governments makes up about 5 to 6 percent of its total outstanding loans, while China Minsheng’s total is 6 percent to 7 percent, Tian said. Big state banks’ lending is between 15 to 20 percent, she calculates.

Barclays Capital forecasts China’s property prices may fall as much as 30 percent in the next 12 months. Kenneth Rogoff, the Harvard University professor and former International Monetary Fund chief economist, said in a Bloomberg Television interview July 6 that a “collapse” in real estate is beginning.

More Than India

The threat facing China’s local governments is another shock wave stemming from the global financial crisis and policy makers’ response to it. As credit froze in the wake of Lehman Brothers Holdings Inc.’s collapse in late 2008, China encouraged a lending spree to cushion the economy. A record 9.6 trillion yuan of loans was issued in China in 2009, more than India’s gross domestic product.

Some local governments set up vehicles to circumvent rules that prevent them borrowing directly. Total local government outstanding debt last year rose to a record 11.4 trillion yuan, according to calculations by Victor Shih, a political economist at Northwestern University in Evanston, Illinois, who has spent months researching local government finances.

The borrowing has effectively pushed China’s overall debt to 71 percent of GDP, Shih said. By comparison, the IMF sees Spain’s ratio this year at 66.9 percent, the U.S. at 93 percent, and Greece at 133 percent. Its estimate for China excluding local-government liabilities is 20 percent.

Overstated Crisis?

Talk of a local debt crisis in China is “overstated,” said Ha Jiming, Hong Kong-based chief economist at China International Capital Corp. He tallies the nation’s total debt- to-GDP ratio as 43 percent, “still one of the world’s soundest.”

Home prices are set to fall as much as 20 percent in a “healthy” correction, Michael Klibaner, head of China research at property broker Jones Lang LaSalle Inc. in Shanghai, said July 7. The property boom has been driven by cash rather than debt, meaning there’s little chance of the forced selling that exacerbated the U.S. housing-market collapse, he said.

Shih said that some local governments are so stretched that “if they don’t sell land within a few months they may have to choose between paying salaries and pension benefits and paying interest payments to the bank.” He identified Tianjin, Chongqing and Wuhan as cities “with higher levels of leverage.”

Special Vehicles

In Tianjin, credit to special financing vehicles last year reached more than 700 billion yuan, according to Shih. Tianjin’s units have also lined up an additional 840 billion yuan in credit lines with banks, he said.

Construction of the 180,000-square-meter Tianjin West Railway Station and transport hub, which will include a 1.3 billion yuan underground link to nearby Tianjin Railway Station, helped propel the city’s economy to a 16.5 percent growth pace last year. The challenge for local leaders will be to sustain that without the bump from land-sales financing.

“To imagine a situation where eventually Tianjin is able to repay all of its debt, you have to believe that it will grow at a phenomenal rate,” said Shih. “There are aspirations and there’s reality.”

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LOS ANGELES (MarketWatch) -- China will let its currency fall if needed to support exports, a Chinese central bank advisor said in an interview published Wednesday.

"Now that there is flexibility in the renminbi, the exchange rate of the currency will decline if it becomes necessary to support exports," Zhou Qiren said in an interview with Japan's Asahi Shimbun.

After almost three years of keeping its currency -- known both as "renminbi" or "yuan" -- tied to the U.S. dollar, China last month began allowing the yuan's daily trading band to fluctuate.

Zhou, a member of the People's Bank of China's top advisory committee, said that Beijing's top focus was keep the exchange rate relatively stable, in part to avoid harming the nation's key export sector.